Shariah banking in Southern California

On a sunny afternoon, Yahia Abdul-Rahman ignores the broken air conditioner in his mortgage-finance company’s cramped Southern California office. Around him, three-dozen employees, some of them Muslim women veiled in scarves, toil amid the rising heat and stacks of paper clutter. Chief lending officer Syed Rehman, 64, his crumpled white shirt rolled up to the elbows, is attempting to close a loan in Urdu, the language of his native Pakistan. In English, he complains that his crowded corner, which he shares with two assistants, is “boiling.”

But the boss, Abdul-Rahman, 60, is as cool as his blue-green eyes. The CEO and founder of American Finance House-Lariba already has succeeded in two previous careers, as a chemical engineer and financial planner. Now, he is creating his legacy in a third: Lariba is among a handful of lenders that dominate this country’s small but growing $600 million Muslim mortgage market.

Governed by the Islamic religion’s sharia laws, which prohibit earning or paying interest on borrowed money, the market is expected to double in the next few years as American Muslims with conventional home loans look to refinance with Islamic products.

Lariba’s interest-free mortgages resemble lease-to-own contracts. Buyers build equity while paying rent and principal. One difference: Lariba homeowners immediately take title while the finance company retains a lien. Its competitors offer variations.

“We are not run-of-the mill marketing people who find a niche and run with it,” says Abdul-Rahman, elegantly attired in a dark suit and sleek tie. “We are humble servants of the community.”

Not 3½ years after the Sept. 11 terror attacks put the U.S.-Muslim relationship in sharp focus, the nascent Islamic finance market is undergoing profound change.

U.S. authorities have identified several Muslim charities as terror-financing fronts. And scandals have erupted at two banks with ties to the Middle East: Arab Bank in New York and Riggs National Bank in Washington, D.C. But the attention also is contributing to the modernization and development of some ancient articles of faith.

Islamic mutual funds and even hedge funds are beginning to flourish, as are interest-free mortgages and business loans. The nation’s estimated 1.1 million American Muslim households, long deprived of sharia-compliant financial products, are benefiting as a result.

Rushdi Siddiqui, director of the Dow Jones Islamic Index Group, which tracks sharia-compliant investments, says, “Frankly, with 9/11, as with any tragedy, there was a silver lining. One of the silver linings … was a revival by Muslims to look inward to how they can be more compliant (with the Islamic faith).” As a result, he says, American Muslims have become better educated about alternatives to Western financial products.

The trickle of new capital is changing people’s lives.

In Sacramento, hospice physician Khurram Ali, 37, a Pakistani immigrant, was living in a rented apartment with his pregnant wife and young son when recently he found a $383,000 house for sale near a Muslim mosque and school.

Having gone without Muslim comforts during the 41/2 years he practiced medicine in South Dakota, Ali feels at home in California. But he was unwilling to buy the property without an interest-free loan.

“I felt so strongly that if we were not able to get financing — which was possible — we were going to stay in our rented apartment,” says Ali, who paid Lariba an “implied” interest rate of about 6% on his loan, making it slightly more expensive than conventional mortgage rates.

Lariba’s implied rate reflects the rental income and any transaction fees calculated as a percentage of the purchase price over the life of the lease-to-own contract. It is tax deductible to the homeowner, just as mortgage-interest expense is to conventional borrowers.

And in Cedar Park, Texas, Altaf Hussain, 43, a semiconductor marketer, just purchased a $475,000 house for his family through Lariba. “With our kids growing up, we wanted to set an example for them,” he says. “I wanted a competitive rate. But, to get out of paying interest, I would have been willing to pay a little higher to get into a Muslim mortgage.”

George Bailey’s lesson

Abdul-Rahman, an imam — or Muslim scholar — likens himself to the small-town banker with a good heart played by actor Jimmy Stewart in It’s a Wonderful Life. He screens an edited version of the movie for new employees and often retells the hallowed Hollywood tale of how townsfolk who invested small savings together created a better life for all.

Since Lariba’s founding in 1987, in a room with a broken window over Abdul-Rahman’s garage, the state-regulated finance company has underwritten more than $200 million in automobile, business and mortgage loans. It originated nearly half that total in 2003, the most recent year for which Federal Reserve data are available.

In turn, secondary-mortgage marketers Fannie Mae and Freddie Mac purchase the mortgages from Lariba for their portfolios, recycling cash back into the business.

Last year, Abdul-Rahman took the helm of a small national bank, the Bank of Whittier, with $26 million in assets, as a vehicle to expand into 49 states. Clients who require more funds or more competitive terms than Lariba can provide are referred to the bank.

Competitors:

• Guidance Financial Group in Reston, Va., a sharia-compliant mortgage finance company founded by French-Syrian economist Mohamad Hammour. It is building a nationwide retail presence, supported by funding from secondary-mortgage marketer Freddie Mac.

Guidance Senior Vice President Rehan Dawer likens the swift development of Muslim mortgage products in this country to the advent of bottled water: initially expensive, eventually indispensable.

• Devon Bank in Chicago, a Jewish family-owned bank, launched Muslim real estate and business-loan products in January 2003 in one of the country’s most diverse neighborhoods. It joined a handful of traditional financial institutions, including HSBC in New York and University Bank in Michigan, in exploring the Muslim market.

Bank attorney David Loundy, a son of Devon’s founder, says he solicited approvals from federal banking regulators and the Sharia Supervisory Board of America for the bank’s Muslim mortgages, which now account for half of its small but fast-growing mortgage portfolio. He also developed savings accounts that replace interest income with profit sharing. The deposit accounts await Securities and Exchange Commission approval.

• Several Muslim-Americans, including principals of Samad Group in Kettering, Ohio, and Shape Financial in Falls Church, Va., are developing other sharia-compliant financial products.

Abdul-Rahman, the son of a former Egyptian undersecretary of education, came to the USA as a chemical engineering graduate student at the University of Wisconsin in February 1968. He had $17 in his pocket and no scholarship. With a job as a teaching assistant, he earned master’s and Ph.D. degrees.

He was destined for good fortune. Upon graduation, Abdul-Rahman joined oil company Atlantic Richfield, later Arco, in Texas, and earned several patents for his work extracting oil from shale.

Living well

His ability to predict commodities prices eventually led him to create his own energy-trading firm and to be named to the board of a local bank. He came to live in one of Houston’s biggest houses, in one of its best neighborhoods.

“I used to make a seven-figure salary and bonuses,” Abdul-Rahman observes. “(But) by the 10th day of the month, our account was empty. My wife used to say: You must be married to somebody else. Where does the money go?”

His wife, Magda, says 70% of their income went to pay for their fancy house, which they financed with a conventional bank loan. Meanwhile, at bank board meetings, he grew uneasy after learning that some directors were defaulting on their loans to the institution.

It was 1983 and the Texas oil bubble was about to burst.

Convinced that a crack in property values would follow, Abdul-Rahman listed his house with a real estate agent for $565,000, even though an enraged neighbor was listing his at $800,000. The couple moved into an apartment.

“Our friends would come and weep and cry” over the apparent reversal of their fortunes, he says. Meanwhile, the neighbor’s asking price fell by two-thirds.

Abdul-Rahman moved on to a job in Southern California as a private banker at Shearson Lehman, a predecessor of Citigroup Smith Barney, and he applied his money-raising skills to underwriting Muslim mosques and schools.

He launched Lariba with the help of about 20 Muslim investors who raised $200,000, enough to finance one interest-free mortgage. “I said, ‘Put in $10,000 (apiece), and if I lose it, don’t hate me for the rest of your life,’ ” he recalls.

In the early days, Lariba financed a home or car purchase only once every six months. But over time, Abdul-Rahman built a profitable business. The big breakthrough came in December 2002, when Fannie Mae pledged to purchase $10 million of Lariba’s mortgages.

With Fannie Mae’s support, mortgage loan applications at Lariba doubled from 27 a month in 2002 — to 54 a month in 2003, according to Federal Reserve data.

At Guidance, the climb was faster. Its mortgage applications soared nearly tenfold to 123 a month, totaling $278.9 million in 2003, up from just $22.4 million in 2002, its first year of business, according to the Federal Reserve. Mortgage applications don’t constitute lending commitments, but most applications in the Muslim niche are funded, market analysts say. Through 2004, Guidance says, it has funded transactions totaling $400 million.

Due to this push, Muslim mosques, newsletters and TV channels now are abuzz with talk about Islamic finance. It convinces Abdul-Rahman that he is living the lead role in It’s a Wonderful Life.

Next, he hopes to reach a broader market. “What we’re trying to preach here is common sense,” he says. “Live within your means. Never just follow the crowd.”

Muslim mortgages

Under Islam’s sharia law, which guides moral conduct, interest-bearing income and debt are considered sinful. But financing may be arranged to incorporate negotiated profit margins and fees rather than compounded interest.

Ijara-wa-Iqtinaa: Lease to own

Home buyer acquires title to property while financier retains a legal claim to the investment. Buyer’s monthly payments to financier include lease and equity components. Title transfers at end of contract.

Murabaha: Installment purchase

Home buyer identifies property and negotiates price, but financier executes transaction with seller. Financier immediately resells property to end buyer on installment-payment plan at pre-agreed markup.

Musharaka: Co-investment

Home buyer and financier are co-owners through a partnership entity such as a limited liability company. Buyer’s monthly payments consist of rental and equity components. Over time, buyer’s equity grows.